The Case For Tax Breaks To Boost Bank Deposit Growth Versus Taxing F&O Transactions

More retail investors keep losing money in the futures and options (F&O) segment of the stock market than anywhere else. And this has become a burning issue for the country's economic Czars, as it involves millions of people.

As a consequence, in an effort to disincentivise uninformed F&O trade, this year’s budget proposals have hiked the security transaction tax (STT) rates on the sale of an option in securities to 0.1 per cent from the existing 0.0625 per cent, and on the sale of a futures in securities to 0.02 per cent from earlier 0.0125 per cent.

Insiders, however, say that Sitharaman’s move to increase the STT on F&O may not be enough to deter people from trading in these complex instruments. Nevertheless, it could well signal the beginning of an exercise to clamp down on derivative trading in India.

Was Reining Retail Players In F&O Needed?

Derivatives are instruments traded based on a predetermined rate. For example, a derivative on sugar is an agreement or contract where one party agrees to buy a certain amount of sugar (say) after six months at an agreed fixed price, from the second party.

That contract then becomes a tradeable instrument in the market.

In 2019, just 7.1 lakh individual traders were dealing in F&O. The number shot up to more than 45 lakh in 2022, an increase of about 500 per cent. Analysts said that it has risen more in the last few months as people looking for quick and easy returns flocked to this trading segment.

A  SEBI study, however, said that 89 per cent of the individual traders (9 out of 10 individual traders) in the equity F&O segment incurred losses, with an average loss of Rs 1.1 lakh during 2021-22.

Given the 2022 aggregate number of individual traders (45 lakh) in F&O, this would be a total loss of more than Rs 40,000 crore in that year.

The Economic Survey pointed out, “Derivatives trading holds the potential for outsized gains. Thus, it caters to humans' gambling instincts and can augment income if profitable”. These considerations are likely driving active retail participation in derivatives trading. 

Added Value Research in a note, “F&O pricing is often swayed not solely by fundamentals but by market frenzy and knee-jerk reactions”.

Shrinking Deposits Vs Rising Stocks

"External elements like market sentiment, speculation, and sudden market reactions can contribute to occasional irrational price fluctuations in the derivatives market, more so than in the stock market", the Value Research note said.

There is also a larger issue of shrinking deposit growth rate in scheduled commercial banks (SCBs) involved in this shifting preference of savings in the economy. The larger picture shows a shift from bank deposits towards the stock market.

While the credit growth of the SCBs is on an upswing, a slowing down of deposit growth may create trouble as the availability of credit for capital formation may well be constrained in the days ahead.

Shifting preferences of household savings towards the stock market will be the main reason if that happens.

Bulls Running Amock In The Market?

India's stock market is on a bull run and market capitalisation to GDP has gone to 124 per cent in December 2023. As Sensex and Nifty scale new highs every now and then, the Indian stock market may be showing signs of “irrational exuberance”. The market capitalisation to GDP ratio (also known as the Buffett Indicator) is definitely on the higher side.

Compared to India's 124 per cent market captalisation compared to GDP, it was 44 per cent, 61 per cent and 71 per cent in Brazil, China and the UK respectively.

The Economic Survey 2023-24 rightly pointed out, “It is essential to strike a note of caution. The market capitalisation to GDP ratio is not necessarily a sign of economic advancement or sophistication.

"Financial assets are claims on real goods and services. If equity market claims on the real economy are excessively high, it is a harbinger of market instability rather than market resilience”, the survey noted.

There is a significant possibility that the consistent rise of Sensex and Nifty in recent times may be signal of a stock market bubble.

Will The F&O Tax Help Bank Deposits?

Indians have been slowly but steadily moving away from bank deposits while opting for other investment options and asset classes.

The  Reserve Bank of India’s (RBI) monthly bulletin for July shows that though bank deposits continued to form the bulk of investments in the total financial wealth basket in 2022-23, it fell below the 50 per cent mark.

In 2011, bank deposits formed 51 per cent of the overall financial wealth basket. It fell to 43 per cent as of March 2023.

“Overall sentiments are positive and the Budget measures will not keep people from the stock market,” Vikram Sahny, MD, Sahny Securities Pvt Ltd, told The Secretariat.

He added, “The STT increase on F&O is not likely to have any impact on the trading… once the sentiments are positive, these get easily absorbed”.

In a pre-budget note, the State Bank of India’s chief economic adviser underlined that if the deposit rates are made attractive slightly nearer to the mutual fund returns, “then this could push up household financial savings and CASA (current account savings account—which are low-cost deposits).”

Meanwhile, last year’s fortnightly deposit growth rates clearly demonstrate falling demand deposit growth and rising time deposit growth.

So, fixed and recurring deposits (FDs and RDs) in the SCBs are still growing upward, while retail banking consumers are shifting away from simple savings bank accounts.

In a high interest rate regime like the current period, the refusal of the banks to increase savings account interest rates while raising the FD and RD rates is the reason behind this emerging trend.

However, if savings deposit growth falls below a certain threshold, it will have a detrimental effect on bank credit growth in future.

Missing: Tax Incentives To Invest In Bank Deposits

The chorus for making savings bank deposits a bit more lucrative with tax benefits got louder during the Budget consultations, but the Finance Minister has not offered much. Though she has increased the STT on F&O and long-term capital gains (LTCG) tax on mutual funds from 10 per cent to 12.5 per cent, the measures are not enough to push people to opt for bank deposits.

“These are measures that are indirectly aimed at boosting bank deposits,” a senior executive at a large public sector bank said. However, he added that these measures are woefully inadequate.  

She said, in an interview, that the banks’ overall approach to mobilising deposits has remained weak.

"I still hold on to this principle that banks need to focus on their core business, which is to mobilise deposits and lend money. Nothing stops them from doing anything else, but this is core," she said.

Section 80TTA of the Income Tax Act allows a maximum deduction of Rs 10,000 if an individual’s total interest income is less than or equal to Rs 10,000.

The person can then claim the complete amount as a deduction. Increasing the ceiling of this limit to (say) Rs 50,000 or even higher could have boosted the prospect of incentivising savings deposit growth.

Perhaps the Finance Minister could have thought “out of the box” and taken a shot at it.